Fund industry planning demise of clones

(February 24, 2005) Since the release of the federal budget Wednesday night, the fund industry has been scrambling to figure out how to deal with the proposed elimination of the foreign content rule and what it will mean for clone funds.

“It’s a victory, [but] quite frankly, we were not expecting this to happen all at once,” says John Murray, IFIC’s vice-president for regulation. “We had hoped the government might reduce the restrictions incrementally. We are very pleased with the results,” he added, noting IFIC would be sending a thank you note on the issue to Finance Minister Ralph Goodale.

Still, IFIC advises that its fund company members, given the Liberal party’s minority position, hold off on making changes until the budget receives legislative approval.

“Nothing truly comes into effect until the budget becomes law,” says Tim Cestnick, managing director of tax and estate planning for AIC. “But it all becomes effective January 1, 2005. The question is do fund companies implement it now, or do they wait for ratification of the law?”

Finance officials confirm the budget proposal to repeal the rule for the full 2005 tax year. If enacted as proposed, it will apply effective January 1, 2005 and in following years.

Since foreign property tax penalties are levied against any amount exceeding the 30% limit at the end of every month, clients exceeding the limits in January and February this year won’t need to worry about the resulting tax bill provided the budget is passed.

If the unlikely event the budget isn’t passed, foreign content holdings exceeding the 30% limits will continue to be penalized.

Cestnick does not recommend clients liquidate their clone funds in favour of the underlying funds just yet, but that they should likely wait until the law has been proclaimed.

“We don’t know if we’re going to go ahead and implement this right away or wait until the budget is ratified,” he says. “My gut opinion is that it makes sense to wait until the law is passed before we make a change. From a practical point of view, I think if we changed it tomorrow, Canada Revenue wouldn’t have a problem.”

Cestnick says that if there is a mass migration of fund companies to act on this tomorrow, it would make sense to join the crowd — citing safety in numbers. But so far, it appears most firms plan to take the cautious route.

“It was a complete surprise to everybody,” said Gavin Graham, vice-president and director of investments, Guardian Group of Funds. “One has to offer hearty congratulations to Mr. Goodale for having the determination to go ahead and remove what was completely unnecessary regulation in the first place.”

Graham says his reading of the budget suggests the changes are in effect immediately.

“As of today, the 30% foreign content limit is no longer applicable,” he says. “That doesn’t necessarily mean that we won’t be calculating it at the end of this month, because it’s set up in the software programs, but we won’t have to charge people 1% of the excess if they’re over.”

He says there is no point in investors taking it upon themselves to make the switch themselves, and that the firm would be contacting unitholders “shortly.”

“Going forward we’re looking at rolling [RSP clone funds] into the underlying funds, logistics permitting. It might not happen immediately, but the necessity of having those funds is no longer there.”

Graham is one of a number of voices joining the chorus of praise for the move. Fund managers and analysts alike agree that it was high time the government lifted the restriction.

“The scrapping of the foreign content limits will produce cost savings for investors who had been employing RSP clone funds, since these funds have higher management expense ratios than the underlying funds to which they are linked,” says Rudy Luukko, investment funds editor at Morningstar Canada. “In the coming weeks and months, we can expect to see a wave of merger proposals from fund firms, as they move to eliminate RSP clones.”

At least one fund manufacturer has announced it will absorb the added costs incurred by unitholders through the use of its clone funds, but that it was waiting for the budget to pass before making any decision on restructuring its lineup.

Brandes Investment Partners issued a release this morning, saying the firm will waive or absorb a portion of the expenses borne by the unitholders for all classes of Brandes RSP funds.

“Clearly there’s no longer an incentive for clients to stay in these clone funds,” said Oliver Murray, president and CEO of Brandes, pointing out the extra layer of costs associated with the forward contracts they entail. “We recognize that clients are going to worry they are paying more of a management fee than they need to, because they could easily shift over to the underlying fund.”

He says the firm also recognizes that advisors have their hands full at this time of year, making sure their clients have made their RRSP contributions in the first place, and do not need the added stress of soothing clients’ concerns over fees.

“We came to the conclusion that the best way to help our clients and advisors is to reduce the fee and therefore they’re indifferent as to whether they are in the underlying fund or the clone fund,” he says.

Brandes is playing it safe and waiting until the budget has been passed, before merging any of the funds, to ensure the firm stays onside with regulations. Murray also says it is still unclear how best to unwind the contracts involved in the clone funds, so the process could take several months.

A spokesperson for AIM Trimark says senior management is meeting to evaluate the company’s options, but that a decision had not been reached.

“AIM Trimark is currently undertaking a review of the implications of potential easing of restrictions to ensure that any transition to a non-restricted environment is done as easily, efficiently, quickly and inexpensively as possible,” the company said in a statement. “Freedom of access to global investment markets has been available, in effect, through the use of RSP versions of many funds for some time. The advantages of a prudent Canadian/global investment mix based on client needs do not change with the budget proposal.”

“We’re hopeful that regulators will view this as something that’s happening right across the industry and has been precipitated by the federal government,” says Murray. “We’re hoping they will provide some administrative relief to fund companies to allow them to more cost effectively do these fund mergers.”

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(02/24/05)

Steven Lamb